If you’re struggling to pay debt, you’re likely considering filing for bankruptcy—and with good reason. Declaring bankruptcy will stop creditors from collecting against you, wipe out debt, give you time to catch up on payments, and help you keep your home or car.
But bankruptcy’s benefits come at a cost. Be sure to consider some significant consequences, as well as the advantages, by reviewing the pros and cons below.
Advantages of Filing for Bankruptcy
Filing for bankruptcy offers solutions to debtors in financial distress. For instance, bankruptcy can do the following:
Stop most creditors in their tracks. Once you file, collection calls must cease. The same applies to many lawsuits, wage garnishments, foreclosures, and repossessions because the court puts an automatic stay in place that prohibits creditors from pursuing you. The stay won’t stop all creditor actions, though. You’ll still pay support payments, and some lawsuits will continue, such as criminal cases. Also, the stay might not apply if you’ve filed multiple bankruptcy cases within a short period.
Get rid of many types of debt. You’ll erase credit card debt, personal loans, medical bills, utility debt, and many other balances. If you secured a debt with collateral, such as a house or car, you can wipe out the debt, but you’ll have to give up the property.
Keep your house or car. If you’re behind on your mortgage or car payment and don’t want to lose the property, filing for bankruptcy will stop a foreclosure or repossession. Chapter 7 won’t help you catch up on your payment, so the stay will likely be temporary. If you want a permanent fix, Chapter 13 provides a way to catch up on late payments so you can keep a house, car, or other property you’ve put up as collateral.
Stop a pending eviction. A bankruptcy filing can buy you more time if you're being evicted. It will stop an eviction that’s still in the litigation process. But the stay will likely be temporary, so it wouldn’t be warranted unless you’d benefit from wiping out debt. In most states, filing for bankruptcy won’t help if your landlord already has an eviction judgment against you. Learn more about bankruptcy and evictions.
Keep property needed to work and live. You don’t give up everything when you file for bankruptcy. Every filer can protect specific property using state exemptions, such as a modest car, furniture, clothing, some equity in your home, and your retirement account.
Get rid of debt for far less than you owe. The cost of filing for bankruptcy is relatively low compared to the amount of debt most people can discharge. Find out the cost of filing for Chapter 7 and how much you’ll pay for Chapter 13.
Disadvantages of Filing for Bankruptcy
Filing for bankruptcy comes with pitfalls, too. Here are some expected consequences that you’ll want to consider.
Bankruptcy will affect your credit score. A filing will remain on your credit report for seven to ten years. But the impact on your ability to get new credit might not be that bad. Getting rid of debt can offset the negative mark of bankruptcy, and you’ll likely get new credit offers soon. Plus, the effect of bankruptcy lessens over time.
You could have a hard time renting an apartment. Having a stable place to live before filing is a good idea. Many management companies won’t work with you if you’ve filed within the last year or two.
Opening a bank account might be difficult. Most banks won’t close your account when you file for bankruptcy if it’s in good standing. But many won’t open a new account after your bankruptcy.
Not all debt will go away. You’ll remain responsible for nondischargeable debt, such as recent tax debt, support obligations, student loans, and more. Older tax debt can be discharged, as can student loans when you show paying them would cause undue hardship.
You can’t keep collateral you can’t pay for. Any property you used to guarantee a loan will return to the creditor if you can’t arrange to catch up or renegotiate the payment. That includes more than just your house, car, or business equipment. It extends to anything you buy on a secured credit card from jewelry, furniture, or electronics stores.
You can’t stop an eviction if the landlord has a possession order (in most states). If a judge already found in favor of the landlord and issued an order giving the landlord the right to possession of the property, bankruptcy likely won’t help. An exception exists if you live in a state that allows you to catch up on your rent after an eviction (there are only a few).
Applying for the Bankruptcy Chapter That Meets Your Needs
Whether you’ll be better off using Chapter 7 or 13 will depend on your qualifications and needs.
- Chapter 7 bankruptcy. Chapter 7 is intended for low-income filers and will wipe out qualifying debt in three to four months. You’ll be eligible if you pass the Chapter 7 means test. Although you can protect some property, you’ll have to give up nonexempt property (property you can’t protect with an exemption). This chapter won’t help you keep a house or car when you’re behind on payments.
- Chapter 13 bankruptcy. This chapter works well for high-income filers who don’t qualify for Chapter 7. Chapter 13 also benefits those who don’t want to give up property in Chapter 7 or want to catch up on a mortgage or car payment. In your repayment plan, you’ll pay your creditors your disposable income or the value of your nonexempt property, whichever is more.
Specific Advantages of Chapter 13 Bankruptcy
Even though most people prefer Chapter 7, Chapter 13 bankruptcy has unique benefits. For instance, you can:
- pay off nondischargeable debt, such as support obligations and past due taxes, over three to five years
- reduce or “cram down” the amount you owe on an asset to the value of the property (you can’t use this for your residence), or
- eliminate a junior mortgage when your house is underwater.
Special Issue of Security Clearances: How Will Bankruptcy Affect a Security Clearance?
While there are no guarantees that bankruptcy won’t prevent you from getting or keeping a security clearance, filing for bankruptcy isn't problematic in most instances. Many organizations look at bankruptcy as a responsible way to address other troubling financial issues, so it might make it easier for you to qualify.
Discriminatory Hiring Decisions and Bankruptcy
Worrying about how filing for bankruptcy might negatively impact your life is understandable. Bankruptcy can affect your ability to finance a car loan, get insurance, or rent an apartment. But filing for bankruptcy might be less of a factor than you think. Specifically, the law prohibits the government from refusing to hire someone based solely on the fact that they filed a bankruptcy case. The provisions labeling such conduct as discriminatory are in Bankruptcy Code section 525.
Filing Bankruptcy Might Help Your Chances of Getting a Security Clearance
Most bankruptcies occur because the filer suffered financial strain due to high medical bills, divorce, or unemployment. Experiencing one or more of these events won’t affect your security clearance much, in all likelihood. The investigating organization would likely view such circumstances as being out of your control.
On the other hand, failing to address the financial effects could jeopardize your position if it reflects a cavalier attitude toward your obligations. The concern is that debt will make you vulnerable to outside influences, lead to rash actions, or even inspire you to engage in criminal activity.
Filing for bankruptcy can remove the intense pressure felt when overwhelmed with debt. Additionally, and more importantly, it will make you less susceptible to behavior that could jeopardize you personally or affect your ability to do your job, such as embezzlement, theft, or bribery.
Most Security Clearance Factors Aren’t Financial
The U.S. Department of Defense issues most federal government security clearances after completing an individualized investigation that probes into many areas of your life. Investigators will delve into factors that might affect your allegiance to the United States and dealings with foreign powers and will likely include gathering information about your:
- sexual history
- mental wellbeing
- drug and alcohol use
- criminal history
- misuse of IT devices
- financial circumstances, and
- other behavior and influences.
So, it’s not the bankruptcy itself that would derail you. The circumstances that led up to the bankruptcy filing will be much more of an issue.
The government is concerned about anything that will influence you to make unwise decisions or make you vulnerable to espionage and blackmail. Things that reflect your character will also affect your fitness for security clearance.
Financial Problems That Could Affect a Security Clearance
That’s not to say that filing for bankruptcy will resolve everything. Your financial history can play a significant role in the investigation, too. You can expect the government to probe for traits that might lead to continued financial problems, such as:
- failing to pay your bills as they come due
- consistently living above your means
- excessive gambling
- drug or alcohol use
- illegal acts (especially embezzlement, tax evasion, theft, or fraud), and
- the truthfulness and timeliness of tax filings and payments.
Remember that while filing for bankruptcy can get you back on your feet, it won’t help solve these problems. It’s not a good idea to file for bankruptcy if you’ve obtained credit through fraud, been less than forthright on your tax returns, or even charged gambling debt. You could open yourself up to more extensive legal and financial problems.
Factors That Can Work in Your Favor
Just looking at your financial behavior won’t tell the whole story. The investigation will also consider mitigating factors that can help alleviate the impact of an adverse event. Specifically, the Department of Defense will consider:
- when the behavior occurred
- whether it was an isolated incident
- if an incident was beyond your control (for instance, a death in the family, loss of employment, a business downturn, an unexpected medical emergency, divorce or separation)
- indications that the problem is resolved or under control
- evidence that you obtained your assets legally, and
- good-faith attempts to repay creditors and settle debts.
Overall, Is Filing for Bankruptcy Worth It?
For many people, the answer is yes. But because each situation is unique, there’s no absolute answer. Here’s a system you can use to help you decide.
- Determine your goal. Do you want to get rid of debt, keep important property, or stay in a home?
- Learn about bankruptcy’s benefits and consequences. See the advantages and disadvantages of filing above.
- Decide whether you should file. If you can achieve your goal, come out ahead financially, and weather the hit to your credit score, it’s likely a good move.
Keep in mind that other factors could come into play when deciding to file for bankruptcy. The simplest way to determine when to declare bankruptcy is to meet with a local bankruptcy attorney, who can review your situation and provide individualized advice.